Pricing for Consumption Economics
SaaS, DaaS, IaaS, and other “X-as-a-Service” business models are proven market disruptors in information technology. Executives at enterprise IT solution providers are creating, adapting, or adjusting to competitors’ XaaS business models. But successfully implementing an XaaS business model requires a new approach to both pricing and revenue capture for IT services. What is that new approach?
J.B. Wood, Todd Hewlin, and Thomas Lah outline a large swath of the drivers and actions to take in their book Consumption Economics: The New Rules of Tech. In this article, we will review and extend their thinking to address key issues in developing a pricing and revenue capture framework for enterprise XaaS providers.
The Revenue Driver for Enterprise XaaS Solves: Benefit and Price Segmentation
From the small business to the Fortune 500, every organization has become dependent upon enterprise solutions. They vary from the generic accounting and contact management solutions to the highly industry- and sometimes client-specific solution. Even the Wiglaf Journal’s small business depends upon no fewer than nine different mission-critical IT solutions to function on a daily basis, and that isn’t even counting the numerous single-point peripherals, devices, software, and data purchased frequently with rarely a detailed cost/benefit evaluation.
As enterprise IT solution providers expanded their footprint across their client organizations, they also expanded their feature set. Today, almost every enterprise solution offers a wide variety of features and functions, most of which no individual would reasonably attempt to learn much less use. Why? Because these features and functions were designed and developed to solve a specific problem for a specific set of customers, then embedded into the software solution and reproduced at no cost to the solution provider.
The result has been a proliferation of functions, most of which don’t provide value to most enterprises. To be clear, each is likely to provide value to some enterprises but very, very few will provide value to every enterprise.
XaaS pricing enables producing firms to shift from “all you can eat” solutions to “you need it, you buy it”, in the words of Wood et al.
For the solution provider, this leads to a finer level of price segmentation wherein (1) customers who benefit from services are charged for the benefits delivered and (2) customers who don’t benefit from certain services can enter the market at a lower price point. As discussed here and elsewhere, price segmentation can improve revenues and profits.
The Cost Driver for Enterprise XaaS: Cloud Computing
One cannot talk about XaaS without mentioning the cloud. But it is listed second rather than first because the cloud acts more as an enabler of Consumption Economics than a driver to Consumption Economics. Without reviewing yet once again the meaning of cloud computing, let us simply acknowledge that it both enables enterprise solution providers to track usage at a finer level and creates value for enterprise solution customers by shifting the management of IT solutions to the companies that make them.
The Effect of Enterprise XaaS on Pricing
XaaS pricing results in what Wood et al. term “micro-transactions”. Micro-transactions are the small fees customers pay to utilize a solution.
In determining the price of micro-transactions, solution providers will rely upon bill factors in developing a billing algorithm.
Bill factors mentioned by Wood et al. include:
- Per app
- Per user-month
- Per feature level
- Per print or per document
- Per GB of data stored
- Per hour of resource used
- Per purchase
- Per data service subscribed
- Per content download
These bill factors can be expanded to include:
- Per employee impacted
- Per dollar impacted
- Per potential user
- Per customer’s customer impacted
- Per part impacted (supply chain)
- Per design impacted (product engineer)
- Others, depending on the nature of the value delivered and means of metering that value.
The billing algorithm then uses these bill factors to determine individual micro-transaction charges. An example billing algorithm for a single SaaS user could be:
Consider what happens with the above approach to pricing. No longer is the enterprise solution provider pricing software, installation, and maintenance. Now, the solution provider is pricing granular-level usage. That is, they are engaging in Consumption Economics.
Consumption Economics forces solution providers to price at a much more granular level. It “unbundles the bundle”. It shifts from buffet pricing to a-la-carte pricing. It requires pricing individual parts of the offering, and then only charging for the parts customers use. It changes transaction pricing from “this is the total price of the solution” to “this is the price to accomplish that specific goal with our solution”. It is a deconstruction of the price structure into the pricing of the individual elements thereof.
This shift to micro-transactions to profit from Consumption Economics is dependent upon the development of a price structure which matches individual points of benefit to a corresponding price to be paid to capture that benefit. Crafting that price structure isn’t simple. More so, crafting a price structure that allows customers to understand what they are paying for what set of benefits requires engaging complexity to reveal simplicity.
XaaS Revenue Capture: Budgeted Spend
Even after the proper bill factors have been identified and the billing algorithm is calculated, very few enterprise customers will want to pay for their consumption on the tap. Face it, no rational enterprise will give a solution to its employees that they can run up the tab on without some level of control. Enterprise customers desire, if not insist upon, predictability.
To manage this selling and customer engagement requirement, we depart from the text by Wood et al. and have noticed that leading enterprise solution providers bill against a “budgeted spend level”.
Budgeted spend levels are the amount of spending a customer will expect to pay for a specific enterprise solution.
Leading enterprise solution providers negotiate for annual spend commitments from their customers, and then bill those customers against their spending commitments on a monthly, quarterly, semi-annual, or annual basis. Micro-transactions are then applied against budgeted spend levels for individual enterprise customers. Customers which are failing to reach their budgeted spend are encouraged to implement the solution further. Customers who exhaust their budgeted spend are encouraged to either purchase more or have their functionality reduced (if not turned off) until the next period’s spending becomes available.
Pricing for Consumption Economics: New but Old
In some ways, Consumption Economics has radically changed the way software is priced and how customers are billed. But don’t be fooled. Despite the technical details and complex changes required to price and bill in the era of Consumption Economics, the principles haven’t changed. Customers will pay for the benefits they derive. Consumption Economics simply forces both suppliers and customers to quantify those benefits. In that sense, the move toward value-based pricing which was somewhat ushered to the forefront due to the IT revolution of the ’80s and ‘90s is now being applied with hyper-veracity in the 2010s under the guise of Consumption Economics.